International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards
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The fair value of the asset has to be determined in accordance with its use by market participants. Entity A’s
future intentions about the asset should only be reflected in determining the fair value if that is what other
market participants would do.
• There are other market participants that would continue to sell the product;
• Entity A could probably have sold the trade name after acquisition but has chosen not to do so;
• Even if all other market participants would, like Entity A, not sell the product in order to enhance the
value of their own products, the trade name is still likely to have some value.
Accordingly, a fair value is attributed to that trade name.
As Entity A is not intending to use the trade name to generate cash flows but to use it defensively by
preventing others from using it, the trade name should be amortised over the period it is expected to contribute
directly or indirectly to the entity’s future cash flows.
5.5.7
Investments in equity-accounted entities
An acquiree may hold an investment in an associate, accounted for under the equity
method (see Chapter 11 at 3). There are no recognition or measurement differences
between an investment that is an associate or a trade investment because the acquirer
has not acquired the underlying assets and liabilities of the associate. Accordingly, the
fair value of the associate should be determined on the basis of the value of the
investment, rather than the underlying fair values of the identifiable assets and liabilities
of the associate. The impact of having listed prices for investments in associates when
measuring fair value is discussed further in Chapter 14 at 5.1.1. Any goodwill relating to
the associate is subsumed within the carrying amount for the associate rather than
within the goodwill arising on the overall business combination. Nevertheless, although
this fair value is effectively the ‘cost’ to the group to which equity accounting is applied,
the underlying fair values of the various identifiable assets and liabilities also need to be
determined to apply equity accounting (see Chapter 11 at 7).
This also applies if an acquiree holds an investment in a joint venture that under IFRS 11
– Joint Arrangements – is accounted for under the equity method (see Chapter 12 at 7).
5.5.8
Assets and liabilities related to contacts with customers
As part of a business combination, an acquirer may assume liabilities or acquire assets
recognised by the acquiree in accordance with IFRS 15, for example, contract assets,
receivables or contract liabilities.
Under IFRS 15, if a customer pays consideration, or an entity has a right to an amount of
consideration that is unconditional (i.e. a receivable), before the entity transfers a good or
service to the customer, the entity presents a contract liability. [IFRS 15.106]. An acquirer
recognises a contract liability (e.g. deferred revenue) related to a contract with a customer
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that it has assumed if the acquiree has received consideration (or the amount is due) from
the customer. To determine whether to recognise a contract liability, an acquirer may
also need to consider the definition of a performance obligation in IFRS 15. That is, at the
acquisition date, the acquirer would identify the remaining promised goods and services
in a contract with a customer and evaluate whether the goods and services it must transfer
to a customer in the future are an assumed performance obligation for which the acquired
entity has received consideration (or the amount is due). Chapter 28 at 5 provides
additional guidance on identifying performance obligations in a contract with a customer.
If a contract liability for an assumed performance obligation is recognised, the acquirer
derecognises the contract liability and recognises revenue as it provides those goods or
services after the acquisition date.
In accordance with the requirements in IFRS 3, at the date of acquisition, an assumed
contract liability is measured at its fair value, which would reflect the acquiree’s obligation
to transfer some (if advance covers only a portion of consideration for the remaining
promised goods and services) or all (if advance covers full consideration for the remaining
promised goods and services) of the remaining promised goods and services in a contract
with a customer, as at the acquisition date. The acquirer does not recognise a contract
liability or a contract asset for the contract with customer that is an executory contract
(see Chapter 27 at 1.3) at the acquisition date. However, for executory contracts with
customers with terms that are favourable or unfavourable relative to the market terms,
the acquirer recognises either a liability assumed or an asset acquired in a business
combination (see 5.5.2.A above). The fair value is measured in accordance with the
requirements in IFRS 13 and may require significant judgement. One method that might
be used in practice to measure fair value of the contract liability is a cost build-up
approach. That approach is based on a market participant’s estimate of the costs that will
be incurred to fulfil the obligation plus a ‘normal’ profit margin for the level of effort or
assumption of risk by the acquirer after the acquisition date. The normal profit margin
also should be from the perspective of a market participant and should not include any
profit related to selling or other efforts completed prior to the acquisition date.
Example 9.12: Contract liability of an acquiree
Target is an electronics company that sells contracts to service all types of electronics equipment for an
annual fee of $120,000 that is paid in advance. Acquirer purchases Target in a business combination. At the
acquisition date, Target has one service contract outstanding with 6 months remaining and for which a
contract liability of $60,000 was recorded in Target’s pre-acquisition financial statements.
To fulfil the contract over its remaining 6-month term, Acquirer estimates that a market participant would
incur costs of $45,000, and expect a profit margin for that fulfilment effort of 20% (i.e. $9,000), and thus
would expect to receive $54,000 for the fulfilment of the remaining performance obligation.
Accordingly, Acquirer will recognise a contract liability of $54,000 in respect of the acquired customer contract.
In addition to the contract liability, an acquirer may also assume refund liabilities of the
acquiree. Under IFRS 15, an entity recognises a refund liability if the entity receives
consideration from a customer and expects to refund some or all of that consideration
to the customer, including refund liabilities relating to a sale with a right of return.
[IFRS 15.55]. A refund liability, therefore, is different from a contract liability and might be
recognised even if at the acquisition date no contract liability should be recognised.
Under IFRS 3, refund liabilities are also measured at their fair value at the acquisition
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date with fair value determined in accordance with the requirements of IFRS 13. The
requirements in IFRS 13 for measuring the fair value of liabilities are discussed in more
detail in Chapter 14 at 11.
If an entity performs by transferring
goods or services to a customer before the
customer pays consideration or before payment is due, the entity presents a contract as
a contract asset, excluding amounts presented as receivable. [IFRS 15.107]. Contract assets
represent entity’s rights to consideration in exchange for goods or services that the
entity has transferred to a customer when that right is conditioned on something other
than the passage of time (e.g. the entity’s future performance). [IFRS 15 Appendix A]. A
receivable is an unconditional right to receive consideration from the customer
[IFRS 15.105] (see also Chapter 28 at 11).
The value of acquired contracts with customers may be recognized in multiple assets
and liabilities (e.g. receivables, contract assets, right of return assets, intangible assets,
contract liabilities, refund liabilities).
Under IFRS 3 at the date of acquisition, all acquired assets related to the contract with
customers are measured at their fair value at that date determined under IFRS 13. The
IFRS 13 requirements for measuring the fair value of assets are discussed in more detail
in Chapter 14 at 5.
When measuring the fair value of acquired contracts with customers, an acquirer should
verify that all of the components of value have been considered (i.e. an acquirer should
verify that none of the components of value have been omitted or double counted). An
acquirer also should verify that all of the components are appropriately reflected in the
fair value measurement.
5.6
Exceptions to the recognition and/or measurement principles
There are a number of exceptions to the principles in IFRS 3 that all assets acquired
and liabilities assumed should be recognised and measured at fair value. For the
particular items discussed below, this will result in some items being:
(a) recognised either by applying additional recognition conditions or by applying the
requirements of other IFRSs, with results that differ from applying the recognition
principle and conditions; and/or
(b) measured at an amount other than their acquisition-date fair values. [IFRS 3.21].
5.6.1 Contingent
liabilities
IAS 37 defines a contingent liability as:
(a) a possible obligation that arises from past events and whose existence will be
confirmed only by the occurrence or non-occurrence of one or more uncertain
future events not wholly within the control of the entity; or
(b) a present obligation that arises from past events but is not recognised because:
(i) it is not probable that an outflow of resources embodying economic benefits
will be required to settle the obligation; or
(ii) the amount of the obligation cannot be measured with sufficient reliability.
[IFRS 3.22, IAS 37.10].
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5.6.1.A Initial
recognition and measurement
Under IAS 37, contingent liabilities are not recognised as liabilities; instead they are
disclosed in financial statements. However, IFRS 3 does not apply the recognition rules
of IAS 37. Instead, IFRS 3 requires the acquirer to recognise a liability at its fair value if
there is a present obligation arising from a past event that can be reliably measured, even
if it is not probable that an outflow of resources will be required to settle the obligation.
[IFRS 3.23]. If a contingent liability only represents a possible obligation arising from a past
event, whose existence will be confirmed only by the occurrence or non-occurrence of
one or more uncertain future events not wholly within the control of the entity, no
liability is to be recognised under IFRS 3. [IFRS 3.BC275]. No liability is recognised if the
acquisition-date fair value of a contingent liability cannot be measured reliably.
5.6.1.B
Subsequent measurement and accounting
IFRS 3 requires that after initial recognition and until the liability is settled, cancelled
or expires, the acquirer measures a contingent liability that is recognised in a business
combination at the higher of:
(a) the amount that would be recognised in accordance with IAS 37; and
(b) the amount initially recognised less, if appropriate, the cumulative amount of
income recognised in accordance with the principles of IFRS 15. [IFRS 3.56].
The implications of part (a) of the requirement are clear. If the acquiree has to recognise
a provision in respect of the former contingent liability, and the best estimate of this
liability is higher than the original fair value attributed by the acquirer, then the greater
liability should now be recognised by the acquirer with the difference taken to the
income statement. It would now be a provision to be measured and recognised in
accordance with IAS 37. What is less clear is part (b) of the requirement. The reference
to ‘the cumulative amount of income recognised in accordance with the principles of
IFRS 15’ might relate to the recognition of income in respect of those loan commitments
that are contingent liabilities of the acquiree, but have been recognised at fair value at
date of acquisition. The requirement would appear to mean that, unless the recognition
of income in accordance with the principles of IFRS 15 is appropriate, the amount of
the liability cannot be reduced below its originally attributed fair value until the liability
is settled, cancelled or expires.
Despite the fact that the requirement for subsequent measurement discussed above was
originally introduced for consistency with IAS 39 – Financial Instruments: Recognition
and Measurement, which was replaced by IFRS 9, [IFRS 3.BC245], IFRS 3 makes it clear
that the requirement does not apply to contracts accounted for in accordance with
IFRS 9. [IFRS 3.56]. This would appear to mean that contracts that are excluded from the
scope of IFRS 9, but are accounted for by applying IAS 37, i.e. loan commitments other
than those that are commitments to provide loans at below-market interest rates, will
fall within the requirements of IFRS 3 outlined above.
5.6.2 Income
taxes
IFRS 3 requires the acquirer to recognise and measure a deferred tax asset or liability,
in accordance with IAS 12, arising from the assets acquired and liabilities assumed in a
business combination. [IFRS 3.24]. The acquirer is also required to account for the
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potential tax effects of temporary differences and carryforwards of an acquiree that
exist at the acquisition date or arise as a result of the acquisition in accordance with
IAS 12. [IFRS 3.25].
IAS 12 requires that: [IAS 12.68]
(a) unlike what was previously required by paragraph 65 of IFRS 3 (2004) acquired
deferred tax benefits recognised within the measurement period (see 12 below)
only reduce the goodwill related to that acquisition if they result from new
information obtained about facts and circumstances existing at the acquisition
date. If the carrying amount of goodwill is zero, any remaining deferred tax
benefits is to be recognised in profit or loss; and
(b) all other acquired tax benefits realised are to be recognised in profit or loss, unless
IAS 12 requires recognition outside profit or loss.
It will therefore be
necessary to assess carefully the reasons for changes in the
assessment of deferred tax made during the measurement period to determine whether
it relates to facts and circumstances at the acquisition date or if it is a change in facts
and circumstances since acquisition date. As an anti-abuse clause, if the deferred tax
benefits acquired in a business combination are not recognised at the acquisition date
but are recognised after the acquisition date with a corresponding gain in profit or loss,
paragraph 81 (k) of IAS 12 requires a description of the event or change in circumstances
that caused the deferred tax benefits to be recognised.
IAS 12 also requires that tax benefits arising from the excess of tax-deductible goodwill
over goodwill for financial reporting purposes is accounted for at the acquisition date
as a deferred tax asset in the same way as other temporary differences. [IAS 12.32A].
The requirements of IAS 12 relating to the deferred tax consequences of business
combinations are discussed further in Chapter 29 at 12.
5.6.3 Employee
benefits
IFRS 3 requires the acquirer to recognise and measure a liability (or asset, if any) related
to the acquiree’s employee benefit arrangements in accordance with IAS 19 –
Employee Benefits (see Chapter 31), rather than at their acquisition-date fair values.
[IFRS 3.26, BC296-BC300].
5.6.4 Indemnification
assets
The seller in a business combination may contractually indemnify the acquirer for the
outcome of the contingency or uncertainty related to all or part of a specific asset or
liability. These usually relate to uncertainties as to the outcome of pre-acquisition
contingencies, e.g. uncertain tax positions, environmental liabilities, or legal matters.
The amount of the indemnity may be capped or the seller will guarantee that the
acquirer’s liability will not exceed a specified amount.
IFRS 3 considers that the acquirer has obtained an indemnification asset. [IFRS 3.27].
From the acquirer’s perspective, the indemnification is an acquired asset to be
recognised at its acquisition-date fair value. However, IFRS 3 makes an exception to
the general principles in order to avoid recognition or measurement anomalies for
indemnifications related to items for which liabilities are either not recognised or are